The March FOMC meeting should reinforce the Fed’s patient approach regarding interest rates, at least until “crosscurrents” dissipate and inflation rises sustainably above 2%
Equities recorded strong gains in the past week, more than offsetting their losses in the first 10 days of March and are up by 1% MtD (11.6% YtD). Investors’ expectations vis-à-vis Chinese fiscal and monetary policy support are growing, while sentiment continues to be supported by the dovish shift by the Fed and trade détente hopes. However, markets (forward-looking) have started to anticipate global growth to stabilize in Q2 and rebound in H2. In that context, euro area, Japanese and US March PMIs (all due on Friday) are significant, with consensus expecting euro area composite PMI at 52.0 from 51.9 in February.
Regionally, the performance in MSCI developed and emerging markets was neck-on-neck at circa 2.5% wow. Sectorally, euro area banks increased by 5.2% (and by 1.6% on Monday), with investors buying heavily on the SX7E in anticipation of a series of M&As, as Deutsche Bank and Commerzbank began merger talks (see Markets). As the ECB does not appear ready to abandon its negative interest rate policy that hurts banks’ profitability, consolidation may be necessary. Recall that euro area banks trade at 0.6x P/BV vs 1.5x P/BV for the market or a 59% discount (vs an average 5-year discount of 50%).
Recall that the ECB revised down significantly its 2019 euro area GDP forecast by 0.6 pps to 1.1%, while growth risks continue on the downside. Inflation forecasts were also revised down (2021 core CPI by 0.2 pps at 1.6%). The policy response was mixed, with: i) interest rate forward guidance extending from September to December; and ii) new TLTRO3s from 2019-2021 indexed to the (prevailing) MRO rate over the life of each operation, with financing terms still unclear.
Regarding US growth, tight financial conditions (a December sell-off in risk assets), the Government shutdown and weather-related weakness will depress Q1:2019 real GDP growth in the range of 0.5% to 1% qoq saar. A GDP rebound in Q2 forms our baseline scenario as the effect of these factors dissipates, with confidence indicators improving slightly. The alarming +20k NFPs gain in February (consensus: +180k) reflects adverse weather conditions and the decline in activity. However, the underlying trend in job growth is stronger (likely at mid 100k).
The Fed, at its meeting on March 20, could announce details regarding the end of its balance sheet contraction, with consensus oscillating around Q3:2019 and a terminal value of circa $3.5tn - $3.7tn (from $4tn currently). Projections regarding interest rates will probably indicate 0 or 1 hike (median) for 2019 from 2 hikes in December. The Fed’s dovish shift will remain (as long as inflation is subdued – see Economics), with most FOMC members: i) supporting no rate hikes at least until “crosscurrents” dissipate; and ii) communicating greater tolerance for a slight overshooting of inflation above 2% in the medium term.
Regarding Brexit, PM May’s amended Withdrawal Agreement was defeated in Parliament by 391-242 (March 12). Furthermore, MPs rejected a “no deal” Brexit (on March 13). The UK Government will now request from Brussels an extension to Article 50, likely until June 30, although a longer extension may prove necessary. Overall, political uncertainty in the UK will remain, with an increased likelihood of a general election (May 2019).